April 15, 2007

Who Pays What on Tax Day

(The following article first appeared in the San Diego Union-Tribune)

It’s almost Tax Day and millions of Americans across the country are mumbling and grumbling as they write big fat checks payable to Uncle Sam. Attitudes about paying taxes are consistent. The majority of Americans say their taxes are too high and less than one in 10 say taxes are too low.

This should surprise no one. The federal tax code is a complex abomination that feeds into Americans’ anxiety over income security. People are generally uncertain about how much they owe from year to year and show strong cynicism about how the money is spent.

Further, more and more Americans believe they are being taxed unfairly. Americans will typically say that the poor pay very little in taxes and the rich are able to circumvent the system to avoid paying their fair share. As a result, grandstanding about the so-called “middle-class squeeze” is now commonplace among our elected officials.

So who exactly is paying all the taxes?

The truth is that the vast majority of federal income taxes are paid by high-income earners. According to the most recent IRS data available, the top 10 percent of households – with incomes roughly $100,000 or greater – pay roughly 70 percent of all federal income taxes. That share is up from just below 50 percent in 1980. If you include the top quarter of all taxpayers, the share balloons to 85 percent.

Interestingly, the cause of these surging payments by high earners has as much to do with demographics as with tax policy. In 1967, most households in the statistical middle fit the traditional notion of the “middle class” – married couples with children living on the income from one breadwinner.

By contrast, today’s statistical middle – people earning between $25,000 and $45,000 – are mostly young and single. People marry later, and they divorce earlier. Forty years ago, middle-income households looked like the family in “Ozzie and Harriet”; today, it is the cast of “Friends.”

And among today’s married couples, few are living on one income. Between 1980 and 2003, the number of dual-income working-age couples grew rapidly, and the extra income catapults these households into the highest income groups.

But just because a couple’s combined salaries seem high doesn’t make them wealthy. For example, a young factory worker earning $18 an hour – or $36,700 per year – clearly falls into the statistical middle. But if she marries a man earning the same amount, their combined income of $73,400 is enough to qualify them to be in the top 20 percent of Americans. Thus, a family can have two “middle-class” jobs with two middle-income salaries, but still be considered statistically high-income according to IRS data.

Still, despite these demographic changes, lawmakers aren’t necessarily off the hook. Recent tax policy changes have created an unsustainable shift in which a diminishing number of Americans overwhelmingly bear the national tax burden.

For instance, many of the tax cuts enacted over the past six years – specifically the doubling of the child credit to $1,000 and the introduction of the new 10 percent bracket – were targeted to help taxpayers in the statistical middle. It is unlikely that lawmakers understood how powerful these measures would be – not only lowering the tax burden for millions of lower-and middle-income taxpayers, but knocking millions of people off the tax rolls entirely, turning them into non-paying tax filers.

The growth of non-payers has been nothing short of remarkable.

Each year the federal government asks for larger and larger sums from a gradually depleting pool of taxpayers. In 2004, some 42.5 million Americans filed a tax return but had no tax liability after taking advantage of their credits and deductions – up from 32 million just four years earlier. Non-payers account for 32 percent of all tax filers, a 160 percent increase in the number of non-payers since 1985.

In addition to these non-paying filers, roughly 15 million individuals and families earned some income in 2004 but not enough to be required to file a tax return. When these non-filers are added to the non-payers, they add up to 57.5 million income-earning households who paid no income taxes.

Even 57.5 million is not the actual number of people because one tax return often represents several people. When all of the dependents of these income-producing households are counted, roughly 120 million Americans – 40 percent of the U.S. population – are outside of the federal income tax system.

In addition, a recently released Tax Foundation study revealed that 60 percent of American households are now net consumers of government spending. That is, a significant majority now receive more in government spending than they pay in taxes. In all, over $1 trillion is redistributed from the top 40 percent to the bottom 60 percent.

It is no wonder people feel the tax code is unfair. The ones paying most of the taxes see little for their return.

While some may applaud the fact that millions of low-and middle-income families pay no income taxes, there is a threat to the fabric of our democracy when so many Americans are not only disconnected from the costs of government but are net consumers of government services. The conditions are ripe for social conflict if these voters begin to demand more government benefits because they know others will bear the costs.

Indeed, the fiscal tsunami of entitlement spending is just a few short years away. Once the baby boomers begin to retire, the call for government services will become louder and louder. Our current fiscal policies have given us no way to pay for it without either drastic cuts or massive tax increases.

If people are grumbling about the check the have to write now, just wait.